Tips to Follow and Traps to Avoid While Investing in Debt Fund

23 February 2023
4 min read
Tips to Follow and Traps to Avoid While Investing in Debt Fund
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Why is it important to save a part of your income? Mainly because it helps meet contingencies in addition to acquiring an asset. Retired individuals depend on interest income and the monthly pension for their day-to-day expenses.

In general, a layman is confused when it comes to making investments. After all, their hard-earned money is at stake. Investors tend to look for the safety of their investments while looking for maximized returns. Commercial banks are considered to be secure when it comes to deposits.

However, remember that you always face interest rate risk and inflation risk.

What is the solution?

The answer is – Debt Mutual Funds.

Does that mean one should only rely on traditional investments?

Because debt funds are volatile, it does not mean that an investor should always stick to fixed deposits and accept low returns.

Traditional instruments may be good from the risk angle, but under rising inflation, these instruments don’t prove to be beneficial.

Thus, it would be wise to balance investments among traditional instruments and debt funds.

Tips to Follow: Debt Funds

  • Determine Your Investment Goals

Before investing in debt funds, it's essential to determine your investment goals, risk appetite, and investment horizon. Debt funds are a relatively low-risk investment option compared to equity funds but they still come with risks.

  • Understand the Credit Rating of the Fund

The credit rating of the fund's underlying securities is an essential factor to consider. The credit rating indicates the issuer's ability to repay the debt. Therefore, look for funds that invest in high-rated securities to minimize credit risk.

  • Check the Expense Ratio

The expense ratio is the fee charged by the fund manager for managing the fund. Look for funds with a lower expense ratio to maximize your returns.

  • Diversify Your Portfolio

Diversification is critical to managing risk. Invest in debt funds that hold securities from different issuers, sectors, and maturities to spread your risk.

  • Monitor Your Investment

Keep a close eye on your investment and make changes to your portfolio if necessary. Market conditions, interest rate changes, and economic factors can impact the value of your investment.

  • Choose the Right Fund Category

Debt funds are classified based on the maturity profile of the underlying securities. Choose the right category based on your investment horizon and risk appetite. For example, if you have a short-term investment horizon, invest in liquid or ultra-short-term funds.

  • Consult a Financial Advisor

If you are unsure which debt funds to invest in, consult a financial advisor who can guide you based on your investment goals, risk appetite, and financial situation.

  • Understand the Types of Debt Funds

Debt funds in India can be broadly classified into three types - liquid funds, ultra-short duration funds, and long-term debt funds.

  • Invest Based on Your Investment Horizon

Liquid funds are suitable for investments with a horizon of up to three months, while ultra-short-duration funds are suitable for investments of up to a year. Finally, long-term debt funds are ideal for investments with a horizon of more than a year.

Traps to Avoid: Debt Funds

  • Assuming That Debt Funds Are Risk-free

Although debt funds are considered less risky than equity funds, they are not entirely risk-free. For example, there is a chance that the borrower may default on the payment, leading to a loss for the investor.

  • Ignoring Credit Risk

Debt funds invest in various debt instruments, including corporate bonds and government securities. Therefore, it is essential to consider these instruments' credit rating and the associated credit risk.

  • Not Diversifying the Portfolio

Investing in a single debt fund or a limited number of debt funds can be risky. Therefore, it is recommended to diversify the portfolio by investing in different categories of debt funds.

  • Not Considering the Interest Rate Risk

Debt funds are sensitive to changes in interest rates. Therefore, an increase in interest rates may lead to a decline in the fund's value and vice versa.

  • Ignoring the Expense Ratio

The expense ratio of debt funds varies from fund to fund. Therefore, it is crucial to consider the expense ratio before investing in a debt fund, as it can impact the returns.

In summary, investing in debt funds in India requires careful consideration of various factors such as credit risk, interest rate risk, and portfolio diversification. Therefore, researching and seeking professional advice before investing in debt funds is essential. 

Feel free to connect with us should you need any assistance.

Happy Investing!

Disclaimer: The views expressed in this fund are that of the author and not those of Groww

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